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BPCL: Research meet extracts
Oct 11, 2006

We recently met with the management of BPCL, refining and marketing major. The focus of the discussion was more on long-term industry trends as opposed to product pricing. Here are the key takeaways from the meeting.

Company background
BPCL is a refining and marketing major with refining capacity of 12 MMT and has more than 7,000 retail outlets and 1,000 kerosene dealers. At present, the company enjoys a market share of 30% in petrol and 26% in diesel. Also, the average fuel sale per retail outlet was 158 KL to 200 KL per month (FY06), depending on the location of the outlet. But the throughput per outlet is significantly higher than the industry average. The company, along with its subsidiaries (Kochi Refineries and Numaligarh refineries), holds 14% of the total domestic installed refining capacity. BPCL is in the process of merging its subsidiary Kochi refineries with itself. The company is also a major shareholder in Petronet LNG and Indraprastha Gas, apart from other gas distribution operations across the country.

Key takeaways:
Growth in sales of petroleum products: Sale of the petroleum products is directly correlated with the GDP growth rate. However, off late, the correlation seems to have weakened due to higher volatility in the crude oil and greater contribution of the services sector to India’s GDP. However, given the fact that the GDP is expected to grow at a rate of 6% to 7%, sales of petroleum products are expected to grow at 3% to 4% per annum. The management expects the growth rate to accelerate (4% to 5% per annum) in the long term on the back of various SEZ getting operational. While naphtha demand is expected to be lower, the company expects ATF (aviation turbine fuel) to outpace the industry.

On BPCL market share: BPCL’s market sales grew at a faster rate as compared to the industry in 1HFY07. Reliance’s market share loss has been captured by the BPCL, thus resulting in a 6% to 7% rise, as compared to 2.5-3.0% that of industry. However, we feel with Reliance reducing prices and increased competition in the future, BPCL is expected to grow in line with the industry. As far as competitive landscape is concerned, the company does not foresee any major threats from existing BPCL retail distributors switching to the private sector.

On the energy basket: Management expects slower growth of alternative fuels and crude oil will continue to dominate the country’s energy basket over the next five years. However, the share of gas in the energy basket is expected to increase in the years to come. Sensing the opportunity, BPCL has entered into various joint ventures for gas distribution in key metros. Thus, the diversification of the revenue stream by the company will drive topline and bottomline growth in the long run at the consolidated level. As far as the outlook for crude oil prices are concerned, the company expects to be in the range of US$ 60 to US$ 70 per barrel in the medium-term.

On the refining margins: Management expects demand for petroleum products in the Asian region to outstrip supply, as the demand for the transportation fuel is showing no signs of weakening. The company expects to earn gross refining margin in the range of US$ 4 to US$ 6 per barrel over the next few years. Though naphtha and furnace oil prices have declined substantially in the Singapore market (because of the shutdown of select petrochemical facilities for maintenance), the same is expected to be higher going forward. Petrochemical manufacturers use naphtha as a fuel.

On the retail expansion plans: With the road network improving considerably, the company foresees opportunities along the national highways for driving volumes. BPCL, in order to improve its hold in the segment, plans to take its one-stop service outlets from 75 (currently) to 200 by the next year. With the addition of new outlets, the penetration level on the highway segment is expected to improve. Reliance has gained market share of 12% (FY06) in retail fuel sales on the back of higher sales along the highways. As far as marketing margins are concerned, the company is comfortable with a margin of Rs 600 to Rs 1,000 per KL (or Rs 0.6 to Rs 1 per litre) on diesel and petrol. Margins in the premium products (like Speed) are Rs 1.1 per litre to Rs 1.2 per litre.

Kerosene and LPG – Lower subsidies going forward: Following the decline in international prices of kerosene and LPG, the subsidy burden is expected to reduce in the near term. However, over the medium-term, restricting the subsidy on kerosene to just below poverty line consumers along with the use of markers to prevent adulteration will result in lower subsidies going forward. If this materialises, one can expect significant upsides to earnings.

On the non-fuel initiative: Currently, BPCL has 375 ‘In & Out’ stores, spread over 66 cities, which it plans to increase to 500 cites. The contribution of the non-fuel revenues to the total revenues is Rs 400 m and the company expected to take it to Rs 1,500 m over the next few years. The average square foot per store is 600 to 1,000 square feet and the company hopes to tie-up with an international retail company in the future to increase the non-fuel revenue contribution. Having said that, one cannot expect any substantial contribution in the next three years.

Capex plans: Recurring capital expenditure of company is between Rs 10 bn to Rs 20 bn (1.4% to 3% of FY06 sales). BPCL plans to spend Rs 20 bn to 25 bn for its Mumbai refinery on the upgradation of the refinery to fulfill Euro-IV norms, while the same for the Kochi refinery is expected to be in the range of Rs 20 bn to Rs 30 bn. Considering the fact that BPCL’s debt to equity ratio is less than 1 times and the outstanding receipt of oil bonds from the government, the company does not foresee any major issues with respect to funding these expansion plans. Also, BPCL is planning to raise Rs 1 bn through the ECB route. As and when opportunities arise on the gas distribution front, BPCL is keen to participate in the same.

What to expect?
Prices of crude and petroleum products have softened from the recent highs. With this, the pressure on the OMCs in the form of higher under-recoveries has eased to an extent. If the crude falls further, the profitability of the OMCs is expected to improve significantly. Margins on the sale of MS (petrol) have turned positive, while diesel margins are at the break-even stage.

While we do not wish to take a crude prices, we will base our estimates with gross refining margins assumed at US$ 4 to US$ 5 per barrel, lower subsidy share on kerosene going forward and marketing margins of Rs 0.6 per litre on petroleum products.

At Rs 404, the stock is trading at a price to book value of 1.5 times FY06 financials (since the company has been incurring losses, price to earnings is negative). We will update our research report on the company this week with our view.

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